Remarks of Commissioner Rostin Behnam at the Michigan Agri-Business Association 2018 Outlook Conference, Mackinac Island, Michigan

Markets and Issues: Lessons Learned and a Path Forward

September 15, 2018

Introduction (and a Bit of History)

Good morning.  It is great to be here with all of you, and a pleasure to kick off this important conference on beautiful Mackinac Island.  Before I begin my remarks, I want to thank our host, the Michigan Agri-Business Association, for the kind invitation to speak with you. Before getting into some of the more recent work of and developments at the Commodity Futures Trading Commission (“CFTC”), I’d like to tell you a little about my personal history and connection with Michigan and the agricultural markets.

In addition to spending many summers in northern Michigan with family and friends, I have also spent many days travelling across the state serving the people of Michigan as counsel to Senator Debbie Stabenow.  From Detroit, Saginaw, and Lansing, to Holland, Traverse City, Marquette, and even Isle Royale, I have had the privilege of spending many hours meeting, and more importantly learning from Michigan producers who care deeply about agriculture and this state’s precious natural resources.  It is with these great memories that I am so honored to be back in Michigan with you this morning.

It’s especially auspicious that I am here on Mackinac Island to talk a bit about the futures markets.  The Island’s strategic location between the Lower and Upper Peninsulas made it a center of commerce for the Great Lakes fur trade as far back as the 17^th century.  Even prior to that, before the Europeans arrived, the Odawa tribe inhabited the Island.  “Odawa” means “traders” or “to trade” in Algonquin.  So, it’s perhaps fitting that I’m standing here before you today in my current role.

Prior to becoming a CFTC Commissioner, I spent more than six years as counsel to Senator Stabenow on the Senate Agriculture, Nutrition, & Forestry Committee.  As a new Committee staffer in 2011, I focused primarily on CFTC issues.  Following the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 (the “Dodd-Frank Act”),[1] the CFTC was at the epicenter of the policy response to the 2008 financial crisis.  A crisis that, many argue, ignited when Lehman Brothers filed for the largest bankruptcy in U.S. history.  This occurred ten years ago to the day, on September 15, 2008.  The Dodd Frank Act brought the CFTC to the forefront of the effort to bring greater certainty and transparency to the derivatives markets, where risk had built up to unfathomable levels and individual financial institutions had grown to such size and complexity as to be systemically important to the U.S. economy and beyond.  As a former Managing Director at Lehman Brothers has remarked, “If the Dodd-Frank Act’s first objective was to limit risk before an institution collapses, the second objective was to limit destruction after a systemically important financial institution has failed or is in danger of failing.”[2]

While the nation’s economy slowly recovered from the devastating loss of millions of jobs and homes, and trillions of dollars of retirement savings, CFTC staff was building a new regulatory framework under Title VII of the Dodd Frank Act for the previously unregulated swaps market.  Ensuring the CFTC got its new rules right was a monumental task for the relatively small agency.  But, without hesitation, I can confidently say, ten years since the crisis, the CFTC, our nation’s derivatives markets, and most importantly, the American public, are in a much better position.

Dodd-Frank Act implementation was not my only priority in 2011.  The 2014 Farm Bill began taking shape, providing me the opportunity to take on additional policy work, specifically learning about agricultural biotechnology and crop protection.  This included working on several titles of the 2014 Farm Bill, and other key pieces of legislation more narrowly focused on biotechnology and crop protection.

Much like the CFTC, my not-to-distant history is rooted in the agricultural markets.  Although I am thrilled and honored to serve in my current capacity, there are few days that go by when I do not think about my old Senate colleagues and the honor it was to serve Michigan while learning so much about agriculture.  But, luckily agriculture is never too far away from my mind in my new job. 

Congress created the CFTC, an independent Federal agency, in 1975.  The CFTC, formerly a part of the United States Department of Agriculture, regulates derivatives transactions, which include futures, options, and now swaps.  Derivatives are financial products, or contracts, whose value is derived from the price of an underlying commodity, which can be anything from a bushel of wheat to a barrel of oil.  Derivatives are widely used by many participants in our economy, including financial institutions, manufacturers, and energy companies.

But, more importantly, our nation’s farmers and ranchers critically rely on the derivatives markets to discover prices and manage their price risk, which can make or break an entire growing season.  It is no coincidence that derivatives are so important to agricultural producers; they helped create the markets.  Dating back to the mid-1800’s, U.S. futures markets have helped alleviate a few of the many challenges agricultural producers face on a day-to-day basis.  Congress enacted legislation in the early 1900’s creating the CFTC’s predecessor agency within the Department of Agriculture.  More than 100 years later, there has been explosive growth in the market place.  The range of contracts offered and traded have expanded from core agricultural commodities, to more complex financial instruments intended to help hedge interest rate and currency risk, to name a few.

As the derivatives markets have grown and evolved, so has the CFTC.  But, the agency’s focus and commitment to the agricultural community is steadfast.  With the benefits of knowing agricultural policy and appreciating the many challenges producers face, from weather and pests, to trade and immigration, I am committed to proposing ideas, examining issues, and supporting policy and solutions that will serve and promote derivatives markets that are fair, efficient, and accessible.  With this commitment in mind, I would like to share some recent developments at the CFTC and also a few areas of policy and events that you can expect in the future.

Nine Months into 2018 (A Little More Recent History)

Although much remains on the CFTC agenda for 2018, this year will certainly be remembered by, at least in part, a first of its kind event held in April known in the Twittersphere as “AgCon 2018.”  The CFTC and Kansas State University’s Center for Risk Management Education and Research jointly hosted a conference, “Protecting America’s Agricultural Markets: An Agricultural Commodity Futures Conference.”[3]  Although I know Michigan State itself could be a formidable host for such a conference, Kansas State did a wonderful job hosting this important event.  Over two days, the CFTC, members of the Kansas State University community, and more than 300 market participants from across the country discussed a range of critical topics affecting agriculture commodity futures, including the role of speculators in futures markets, high frequency trading, contract design, and advancements in financial technology.  These were critical discussions that have provided the CFTC with important input, and certainly set the tone for improved policy in the future. 

More personally, I used AgCon as an opportunity to convene the CFTC’s Agricultural Advisory Committee.  As the sponsor of the Agricultural Advisory Committee, I have the unique opportunity to hold public meetings with a broad cross-section of representatives of the agricultural community in an effort to discuss current issues, and reconsider rules that may be creating unnecessary and costly regulatory burdens.  Given the breadth of topics discussed at AgCon, I decided to pivot from the typical market structure topics and focus on issues truly unique to production agriculture:  (i) the intersection of crop insurance and the futures markets; (ii) credit’s role in risk management and the Farm Credit System; and (iii) block trading in agricultural futures products.[4]

Given the critical importance of crop insurance as a risk management tool for growers and the ongoing 2018 Farm Bill discussions, I thought it timely to discuss the relationship between the futures markets and crop insurance, in an effort to identify and progress towards resolving issues that may exist between the two.  With a distinguished panel of speakers, including the Department of Agriculture, the Advisory Committee and the Commission were able to learn and better understand the importance of a functioning futures market to the crop insurance program.  As the best aggregator of information and prices, and the best venue for identifying forward looking prices, the futures market serves as a critical tool for reference prices and insurance coverage determinations.  These relationships further emphasize the importance of well-functioning futures markets and put the onus on the CFTC and market participants to ensure issues like convergence of cash and futures prices are addressed in policy and practice.

The second topic explored the relationship between the Farm Credit System and risk management.  Established a little over a century ago, the Farm Credit System is comprised of a network of borrower-owned lending institutions that provide hundreds of billions of dollars in loans, leases, and related services to farmers, ranchers, rural homeowners, agribusinesses, and others.  The Farm Credit System operates in a mutually beneficial relationship with its borrowers and beneficiaries, and, simply put, I believe a borrower’s ability and willingness to hedge risks using the futures market creates a more stable lending environment.  Given record low commodity prices, significant trade challenges, and labor concerns, among other issues, accessible and favorable credit becomes even more vital today than in other years.  Speakers from the Farm Credit Administration shared key issues that lenders focus on when entering into a relationship, and how a producer can best position his or herself to access credit.  Among many lessons, my key takeaway was continued education about the futures market in promoting better access to credit.

Finally, the advisory committee discussed block trades.  Block trades are privately negotiated transactions that are permitted to be executed apart from an exchange’s central limit order book.  The central limit order book, or CLOB, is the most conventional, transparent and efficient mechanism to match buyers and sellers -- essentially a two column ledger anonymously showing all buy and sell orders, and matching the highest bid with the lowest offer. Block trading has proved to be a useful tool for institutional market participants who need to execute large transactions (or combinations of transactions) or “blocks” with one party at a fair and reasonable price relative to the price listed on the CLOB.

In January, 2018, the Chicago Mercantile Exchange (“CME”) launched block trading for the full suite of agricultural futures and options on futures products.  Prior to that time, the CME had allowed block trades for only eleven products in the agricultural asset class.  Shortly thereafter, market participants expressed concerns regarding liquidity, price transparency, and trade reporting in the contracts that had block trades.

The Agricultural Advisory Committee served as the perfect venue, three months following the initial listing of the CME agricultural block trades, to have a discussion and examine what was working and what was not working.  I am pleased to say that following the Advisory Committee meeting, working in cooperation with CFTC staff and the CME, many issues have been addressed and resolved.  In July, the CFTC issued a report by the staff of the Market Intelligence Branch in the Division of Market Oversight (“DMO”) entitled “Agricultural Block Trade Analysis.”[5]   Based on analysis of all grain, oilseed, and livestock transactions from January 8 through March 31, 2018, CFTC staff’s key findings included that:  (1) block trades in the agricultural space comprise a very small portion of overall volume, but are somewhat more significant on specific dates and for certain contract months; (2) block trades are primarily occurring in nearby months; and (3) prices of blocks appear to be priced within the CME rule for “fair and reasonable prices.  DMO staff is continuing to monitor block trades and the CFTC remains vigilant to ensure that block trades are not interfering with end-users’ ability to manage risk and discover prices in a fair and efficient manner.

Looking Ahead

The CFTC has a lot to look forward to in the coming months and years.  In the past two weeks, the CFTC has welcomed two new Commissioners, giving the agency a full panel of five Commissioners.  With a full Commission, I am confident that the Chairman will move forward more aggressively with his agenda.  I am hopeful that the Commission will—at the very least—prioritize completion of the long overdue position limits rule, mandated by the Dodd-Frank Act.  This rule will no doubt play a critical role in ensuring our markets are transparent, safe, and free from fraud and manipulation.

I’d also like to see the Commission revive its commitment to address technological developments in our markets that pose operational risks.  In this age of technology driven financial markets, the question of a flash crash or automated trading system failure is not a question of if, but simply when.  I anticipate that the Market Risk Advisory Committee or MRAC, the other CFTC advisory committee I sponsor, will spend some time in the fall focusing on operational risk—the risks resulting from breakdowns in internal procedures, personnel, and systems.  It includes fintech risks such as service disruptions, data compromise, and cybersecurity.  It also includes risks from outsourcing and use of third-party products and vendors.  And, it includes fraud and other personnel misconduct.

Additionally, I expect that the full Commission will vote on a final rule addressing the de minimis exception to the swap dealer definition before the end of this year.  Although I did not support the proposal[6] in June, I am looking forward to working with the Chairman and my fellow Commissioners to find consensus on a final rule that balances the need for a strong dealer regime, while ensuring our nation’s end-users, including the agricultural community, have fair and open access to the swaps market.

As we quickly march towards 2019, I suspect that the CFTC will return to Kansas next spring for a second commodity markets conference—I believe #AgCon2019 might already be out there.  I encourage all of you to engage with the CFTC, certainly my office included, to ensure that we are discussing the right issues affecting your businesses on a day to day basis.  I mentioned earlier in my remarks how happy I am to be back in Michigan.  To that end, I welcome future visits to see your operations first hand.

But Not Forgetting Our Recent Past

I would like to end my remarks on a slightly different note.  As I mentioned earlier, today is in fact the tenth anniversary of the Lehman Brothers bankruptcy.  Lehman Brothers was one of the world’s largest investment banks, with a history dating back to the mid-19th century; much like the futures markets themselves.  Lehman’s demise started a cascade of events that led to a prolonged financial crisis and ultimately the Great Recession.  Although those events took place many miles away from Mackinac Island, its repercussions were felt all across the rural economy and the globe.  Trust was broken.  The CFTC was certainly at the heart of the crisis in many ways.  Although different factors led to the crisis itself, the yet-to-be regulated over-the-counter swaps market played a significant role in exacerbating the litany of problems that seized financial markets.

Ten years past, we have all learned a lot about the stability of our financial system, the inter connectedness of very different parts of our economic ecosystem, and most importantly the resiliency of Americans.  Ten years past, the economy is strong and unemployment is at record lows.  Ten years past, the CFTC is a very different agency. The Dodd-Frank Act mandated a regulatory regime of the swaps market that has made it safer, more transparent, and arguably more efficient.  All positives for the swaps markets, and ultimately for all of us as beneficiaries of stable prices for goods.  There is always more work to be done, and the CFTC, myself included, work hard to ensure that we remain vigilant to the risks that infect our markets, and to identify danger before it’s too late.

As I enter my second year as Commissioner, I am cautious of the rhetoric and economic tailwinds that threaten to uproot the regulatory landscape that is only just beginning to show its strength.  I am cautious because I appreciate that this opportunity to second guess our progress to date is a luxury and that any choices we make may be colored by the recent tide of populist sentiments and information asymmetries.  I’m committed to continuing to defend the regulations that our predecessors—with the full input of the public—got right, to keep an open mind to making strategic edits when necessary, and to support and prioritize issues that have remained in the margins but which should be front and center on our agenda.  I am committed to demanding transparency and adherence to process.  And I am optimistic that our Commission is now fully staffed and has the experience, expertise, and hindsight to collaborate and engage towards decision making that will continue to move the CFTC and the markets it regulates forward.

Conclusion

I want to thank Michigan Agri-Business again for inviting me to speak.  Given the many challenges the agricultural economy is facing today, I hope my words today will bring some certainty that the CFTC is dedicated to serving Michigan and our nation’s farmers and ranchers.  I often give historical context to the CFTC to remind myself of its priorities.  The agency’s roots are in agriculture.  As Congress considers a five-year Farm Bill to provide the rural economy with the necessary risk management tools and investment it needs, please consider the CFTC in the same light.  Thank you.